RBI’s New Rules on Non-Profitable Assets and Credit Risk Management Explained

The Reserve Bank of India (RBI) has rejigged its rules for identifying and managing bad loans from April 1, 2027. The aim is to bring India’s banking system closer to global standards. The central bank said these changes will improve how banks handle credit risk. They will also make it trouble-free to compare financial data across banks and align the regulatory framework with international practices.

Modification in NPA Classification

Under the new rules, banks must follow stricter guidelines when classifying loans as Non-Performing Assets (NPAs). If a borrower has multiple loans and one becomes an NPA, all loans of that borrower will be treated as NPAs. A loan will still be marked as NPA if payments are overdue for more than 90 days.

To upgrade a borrower back to a “standard asset”, the borrower must:

• Pay all pending interest.
  
• Repay the full principal amount across all loans.
• Banks must also use automated systems to identify NPAs. This replaces the earlier manual process.

New Method for Calculating Loan Losses

The RBI has introduced a new system called Expected Credit Loss (ECL). This method helps banks prepare for possible losses in advance.

ECL works in three stages:

• Loans with low or no credit risk
• Loans where the credit risk has increased significantly
• Loans that are already in default

This method is stricter than the earlier “Incurred Loss” approach, where banks made provisions only after a loan became overdue for 90 days.

Introduction of Effective Interest Rate

The RBI has also changed how banks calculate interest for loss estimation. Banks will now use the Effective Interest Rate (EIR). Earlier, they used the contractual interest rate. EIR is calculated based on expected cash flows and all loan terms, except the potential credit loss.

Timeline for Implementation

• New loans from April 1, 2027, will follow the EIR system.
  
• Banks must convert old loans to the new system by March 31, 2030.